EXECUTIVE SUMMARY

TIGTA
made recommendations regarding the use of individual tax
identification numbers (ITINs) with respect to refundable
tax credits such as the child tax credit. TIGTA also
recommended that the IRS develop a new process to prevent
erroneous claims for the earned income credit.

The IRS issued guidance providing the
procedure for electing under Sec. 108(i) to include income
from indebtedness discharged in a reacquisition of a debt
instrument in gross income ratably over a five-year
period.

The IRS issued advice
to its employees regarding the determination of whether a
taxpayer can claim a dependency exemption for a
noncustodial child, and several courts ruled on this issue
in specific situations.

The
IRS rejected a Tax Court position and advised that
indebtedness incurred to acquire, construct, or
substantially improve a residence that exceeds $1 million
is not acquisition indebtedness. However, the IRS states
that up to $100,000 of such debt can be treated of such
debt can be treated of such debt can be treated equity
debt exists), thereby allowing interest on $1,100,000 of
the debt to acquire the home to be deductible.

The Treasury Inspector General for Tax Administration
(TIGTA) semiannual report to Congress for the period October
2008–March 2009 includes a recommendation that legislation is
needed to clarify whether refundable tax credits, such as the
additional child tax credit, may be paid to filers without
valid Social Security numbers.1 Currently, an
individual taxpayer identification number (ITIN) is available
to any resident or nonresident alien who is unable to obtain
an SSN but has a tax return filing requirement. Each year the
IRS approves billions of dollars in tax credits claimed by
ITIN filers with-out adequate verification of eligibility. In
tax year 2007, for example, more than 1.2 million (66%) ITIN
filers received additional child tax credits of $1.8 billion.
The TIGTA report says payment of federal funds to ITIN filers
is inconsistent with federal law and policy.

Specifically, TIGTA recommends that the IRS develop
processes to:

Identify individuals who are
improperly using ITINs for work purposes and develop
outreach efforts with the Social Security Administration to
address the improper use;

Limit the automatic
population feature for ITIN tax returns;

Ensure that accurate tax information is put into the IRS
systems from both paper and electronically filed ITIN tax
returns; and

Ensure that the requirements for
the child tax credit and the additional child tax credit are
met on ITIN returns claiming the credits.

Further, in cases in which the credits may not be paid,
TIGTA recommends that the IRS be given math error authority to
disallow associated claims for credits.

The IRS
management agrees with the recommendation. The IRS management
agreed to continue to work with software companies to limit
the auto-populate feature and also agreed to work with
Treasury’s Office of Tax Policy to consider legislation to
limit claims for the additional child tax credit to taxpayers
with an SSN. However, the IRS disagreed with the other
recommendations, although the report says TIGTA does not
believe that the IRS management provided adequate
justification for the disagreement.

Sec. 24: Child
Tax Credit

A bankruptcy court has held that a
nonrefundable child tax credit is not exempt property under
state law in Colorado.2 It disallowed a couple’s
claimed exemption for that amount and ordered the couple to
turn over the pre-petition portion of their 2008 income tax
refund to the bankruptcy estate.

Sec. 25: Interest on
Home Mortgages

The Government Accountability Office
(GAO), in a July 2009 report, made seven recommendations to
the IRS regarding home mortgages:3

Revise the National Research Program’s case selection
system so a tax return’s mortgage interest deduction is not
automatically excluded as an examination issue if it matches
information reported on Form 1098, Mortgage Interest
Statement;

Revise Form 1098 to require third
parties to provide information on mortgage balances, the
address of a home securing a mortgage, and an indicator of
whether the mortgage is for a current-year refinancing;

Investigate whether using information from
private sources would be productive in detecting mortgage
interest noncompliance, especially for home equity debt;

Revise the wording on Schedule A, Itemized
Deductions, to clearly state that the mortgage interest
deduction is subject to limitations;

Conduct a
test to evaluate whether mortgage interest deduction–related
outreach programs to taxpayers and tax return preparers
could be a cost-effective way to reduce noncompliance.
Outreach might include sending correspondence covering key
rules and common mistakes or promoting seminars on common
types of misreporting;

Set a date to complete
the Chief Counsel determination on whether the acquisition
debt limit is $1 million or $1.1 million when used in
combination with the home equity debt limit; and

Revise examiner training materials by adding examples
cited as common problems by auditors and paid tax return
preparers, such as those involving multiple homes or
home-based businesses. After the Chief Counsel’s final
determination on the acquisition limit, revise examiner
training and the worksheet in guidance to reflect the
project’s outcome.

The GAO received written
comments from the IRS on July 23, 2009. The IRS agreed with
five of the recommendations and agreed to study the other two.

The IRS acknowledged that without information about
taxpayers’ mortgage debts, it cannot easily detect taxpayer
noncompliance with the mortgage interest deduction limits. It
also said that the absence of information about noncompliance
prevents it from efficiently deciding how to select cases for
review and noted that the complexity of the rules causes
problems for some taxpayers.

Regarding the
recommendation to revise Form 1098 to include more information
on taxpayer mortgages, the IRS agreed to study the issue,
saying it does not have enough data to support revisions at
this time. Because the IRS acknowledged in its comments that
it does not have information about taxpayers’ mortgage debts
to easily detect noncompliance, the GAO believes that the
recommended revisions to Form 1098 would be cost-effective
ways to provide the IRS with additional useful information to
help it detect noncompliance.

Concerning the
recommendation to conduct a test to evaluate whether mortgage
interest deduction–related outreach programs could be a
cost-effective way to reduce noncompliance, the IRS said it
would study the feasibility of such a test. It also addressed
the question of whether the acquisition debt limit is $1
million or $1.1 million in chief counsel advice released in
October, discussed in the coverage of Sec. 163 on p. 183.

Sec. 32: Earned Income Credit

The TIGTA
semiannual report to Congress includes a recommendation that
the IRS conduct a study to identify alternative processes that
will expand its ability to effectively and efficiently
identify and adjust erroneous earned income tax credit
claims.4

TIGTA also recommended that the
IRS work with the Assistant Secretary of the Treasury for Tax
Policy to obtain the authority necessary to implement
alternative processes to adjust erroneous earned income tax
credit claims. The IRS management agreed with the
recommendations and has planned appropriate corrective
actions.

Sec. 36: First-Time Homebuyer’s Credit

The Worker, Homeownership, and Business Assistance Act of
2009,5 signed into law on November 6, 2009,
extended the first-time homebuyer’s credit, which had been set
to expire on November 30, 2009. The act provides that
taxpayers who enter into a binding contract before May 1,
2010, to close on the purchase of a principal residence before
July 1, 2010, are eligible for the $8,000 credit.

Income limitations to qualify for the credit were increased
so that the credit phases out for individual taxpayers with
modified adjusted gross income between $125,000 and $145,000
($225,000 and $245,000 for joint filers) for the year of
purchase. Further, taxpayers may elect to treat the purchase
of a principal residence in 2009 or before the new deadline in
2010 as made on December 31 of the calendar year preceding the
purchase. Finally, no credit is allowed for taxpayers under
age 18 on the date of the purchase or for the purchase of any
residence costing more than $800,000.

The law expands
the credit to include “long-time residents of the same
principal residence” for purchases made after November 6,
2009, the effective date of the new provisions. That is,
taxpayers who have owned and used the same residence as their
principal residence for any fiveyear consecutive period during
the previous eight-year period ending with the date on which
the new residence is purchased are eligible for a $6,500
credit. The new phaseouts and age/cost limitations also apply.

Military families are provided some relief; the credit
recapture rules are waived for members of the U.S. uniformed
services (Army, Navy, Air Force, Marines, Coast Guard, and
commissioned corps of the U.S. Public Health Service and the
National Oceanic and Atmospheric Administration), Foreign
Service, and intelligence community who are called to duty
before 36 months after the date of purchase. The act also
extends the credit for those individuals on qualified official
extended duty outside the United States to purchases made
before May 1, 2011 (or July 1, 2011, for taxpayers with
binding contracts in place before May 1, 2011).

In an
effort to curb fraud and abuses of the credit, the law gives
the IRS math error authority to disallow the credit during
processing, excludes dependents and related parties from
claiming the credit, and requires taxpayers to attach a copy
of the settlement agreement to the tax return.

Sec.
59: Other Definitions and Special Rules

The D.C.
Circuit affirmed a Tax Court decision holding that U.S.
citizens living in Canada were subject to the 90% foreign tax
credit limitation for AMT purposes.6 The appeals
court rejected the taxpayers’ attempt to distinguish the facts
of their case from Kappus,7 in which the
D.C. Circuit concluded that even if Sec. 59(a) (2) conflicted
with the U.S.-Canada tax treaty, the statute prevailed because
it was “last in time.”

The taxpayers argued that the
court “could reconcile the treaty and the statute by allowing
the taxpayers to claim foreign tax credits after
their entire U.S. tax liability (including AMT) has been
calculated…. Under this reading § 59(a) (2) normally would
affect the total tax liability only of taxpayers who worked in
a foreign country that, unlike Canada, did not have a treaty
with the United States limiting ‘double taxation.’” The court,
however, wrote that the statute “does not on its face suggest
that it was intended to have such a narrow impact.”

Sec. 61: Gross Income Defined

The IRS notified
taxpayers that while a voucher received by a car owner under
the cash for clunkers program is excluded from income, the
amount received by the car dealer is income.8

The IRS also ruled that payments parents receive from the
school board for services of a nonpublic school are not
taxable income to them.9 Instead, they are a
reimbursement of costs required to be incurred by the school.

Sec. 72: Annuities

In a Tax Court case, the
taxpayer was a nurse working in a VA hospital.10
The taxpayer suffered emotional distress after a patient died,
and there were periods during which he was suspended from work
or directed by his doctor to have only light duty. Issues with
the VA hospital eventually led to the taxpayer’s early
retirement for disability. About one month later, the taxpayer
took a job with another health clinic.

He filed a
financial hardship form and received a distribution of
$158,000 from his 401(k)-type plan (the taxpayer was not yet
age 59½). The IRS found that the taxpayer was subject to the
10% additional tax under Sec. 72(t). The court agreed with the
IRS that the taxpayer was not disabled per Secs.
72(t)(2)(A)(iii) and (m)(7). The court also found that the
taxpayer reasonably relied on his long-time tax preparer, so
there was reasonable cause for the taxpayer’s understatement
due to the distributions.

Sec. 108: Cancellation of
Debt (COD) Income

Sec. 108(i) election: Rev. Proc. 20093711
provides the exclusive procedure for electing under Sec.
108(i) to include income from indebtedness discharged in a
reacquisition of a debt instrument in gross income ratably
over a five-year period. The period for including the income
begins with the fifth or fourth year after the year of
reacquisition for reacquisitions occurring in 2009 or 2010,
respectively.

Sec. 108(i) applies to debt instruments
issued by C corporations or by any other person in conjunction
with the conduct of its trade or business. A reacquisition is
an acquisition by the issuer; an acquisition can include an
exchange resulting from a debt instrument’s being modified.

To make the election, the taxpayer must attach a
statement to the timely filed (including extensions) tax
return. The IRS can grant an automatic extension of 12 months
from the tax return due date fo making the deferral election.
The revenu procedure lists the required content the election
statement.

The taxpayer can elect to defer or just a
portion of the income from the cancellation of the debt. Thus
if a taxpayer realizes $100 of COD income, the taxpayer can
make an election to defer $40 and exclude the remaining $60
from income under the other Sec. 108 provisions, if
applicable.

Furthermore, a taxpayer who believes that
a transaction does not trigger COD income can make a
protective election. In other words, if the taxpayer has a
transaction that may be considered COD income but is taking a
position that it is not, he or she can attach a protective
election to the return. That way, even if the statute has
closed on the year in question, the IRS can require the
taxpayer to pick up the deferred income in the subsequent
years.

Except in the case of protective elections, the
taxpayer must attach statements to the tax returns for each
tax year after the tax year of the election through the first
tax year in which all the deferred income has been recognized.

For noncalendar-year taxpayers, Rev. Proc. 2009-37
provides a transitional rule for returns filed on or before
September 16, 2009, if the taxpayer uses “any reasonable
procedure to make the election.” However, if the election does
not comply with the procedures listed in the revenue
procedure, the election will not be effective unless the
taxpayer filed an amended return that complies with the
procedures on or before November 16, 2009.

Forgiven debt: In a Tax Court decision, a
bank forgave the taxpayer's credit card debt of $4,156. 12 He
had argued that the debt was discharged in bankruptcy and thus
he did not have gross income. He had filed for bankruptcy, and
the bankruptcy court confirmed an installment plan for paying
debts over a 60-month period. Because the taxpayer ceased
making the required payments, the court dismissed his
bankruptcy case for “material default.” The taxpayer did not
provide any evidence that he was insolvent. Thus, the court
held that he must recognize gross income equal to the amount
of the forgiven debt.

In Melvin, the
taxpayers owed $13,084 on a credit card and engaged a firm
(Arbitronix) to negotiate a settlement with the credit card
company.13 Arbitronix was able to get the debt
reduced by $8,505, for which it charged the taxpayer a fee of
25%, or $2,126. The bank issued a Form 1099C, Cancellation of
Debt, showing $8,768 of income for 2005. (There is no
explanation for the difference in the amounts of $8,505 and
$8,768.) The taxpayers did not report any COD income on their
2005 return but amended that return in 2007 to include $8,768.
At trial, the taxpayers conceded that they had $8,768 gross
income and amended their pleadings to that the fee to
Arbitronix was deductible. On brief, the taxpayers argued that
some of the charges were erroneous and that they hired
Arbitronix to contest the alleged amount owed.

The
court agreed with the IRS that because the taxpayers conceded
the issue, they could not deny that they had income. The court
did address whether some of the charges were contested and
found that the taxpayer had introduced no evidence regarding
disputed charges. The court disallowed a deduction for the fee
paid to Arbitronix. The taxpayers acknowledged that they could
not deduct the fee under Sec. 162 (because they had no trade
or business) or Sec. 212 (because they could not deduct
miscellaneous itemized deductions for the AMT). As authority
for the deduction, the taxpayers had cited Sec. 61(a)(12),
income from discharge of indebtedness. Another case involved a
different Melvin with forgiven debt.14 The
taxpayers owed about $40,000 of unsecured debts, a good
portion of which was attributable to medical expenses. They
did not own their own home and had “only a small amount of
personal property.” One creditor forgave the taxpayers’ debt
and filed a Form 1099-C. The IRS assessed $3,000 of taxes on
forgiven debt but apparently did not try to determine whether
the taxpayers were solvent before assessing the taxes.

The taxpayers did not use any administrative procedures
within the IRS but brought a case in bankruptcy court for a
determination that they were insolvent at the time the
creditor forgave the debt. The government argued against the
bankruptcy court’s deciding the issue on policy grounds. The
government’s position was that the case was a no-asset chapter
7 case with no distribution to be made to creditors due to the
lack of assets. It argued that the court should not hear the
case because there was no “bankruptcy purpose” for hearing it.

The bankruptcy court concluded that most of the evidence
needed to make the determination of insolvency was already
developed, and it denied the government’s position that it
should abstain from deciding the insolvency question. The
bankruptcy court pointed out that if it did not hear the case,
the taxpayers would have to go to federal district court to
prove they were insolvent and that to litigate there they
would first need to pay the tax in question, “something the
Debtors do not have the wherewithal to do.”

The Tax
Court issued several other opinions during 2009 related to COD
income resulting from reductions in credit card
debt.15 Taxpayers are required to include in income
any credit card debts that a company cancels or forgives
during the year unless one of the Sec. 108 exclusions applies.
In the recent cases, none of the taxpayers involved was able
to present any testimony to support a finding of insolvency.

Late election: In a private letter
ruling,16 a taxpayer was permitted to make a late
election to apply Sec. 108(c) to mortgage debt forgiven during
the year in question because it was determined that the
taxpayer had acted reasonably and in good faith. The taxpayer
had not attached Form 982, Reduction of Tax Attributes Due to
Discharge of Indebtedness (and Section 1082 Basis Adjustment),
to the originally filed return and attempted to file an
amended return to make the election to reduce the basis of the
business property. Instead, he was required to file a letter
ruling to obtain permission.

Practice tip: IRS Publication 4681,
Canceled Debts, Foreclosures, Repossessions, and Abandonments (for Individuals) for Use in Preparing 2008 Returns (2009), is a
helpful publication that includes explanations, examples, and
filledin tax forms. Although the title refers to 2008 returns,
the publication should also prove useful for later years.

Sec. 121: Exclusion of Gain from Sale of Principal
Residence

In Letter Ruling 200936024,17
the taxpayer had owned and occupied a house as a principal
residence for about 20 years before moving out and employing a
contractor to make improvements. Shortly after starting to
work, the contractor discovered a hazard that had previously
been concealed. State law precluded further work until the
hazard was removed. After removal of the hazard, construction
of the improvements resumed. The taxpayer listed the house for
sale after the improvements were finished. The taxpayer sold
the house in Month E after having moved out in Month A.

The IRS ruled that the taxpayer met the requirements of
owning and using the property until Month D, the date the
contractor finished the improvements and the taxpayer listed
the house for sale. Thus, it ruled that the entire gain was
excludible.

Sec. 151: Allowance of Deductions for
Personal Exemptions

For tax years beginning after
2009, the rules phasing out personal exemptions for higher
income taxpayers no longer apply.18 However, unless
Congress takes action, the phaseout rules will return in their
pre-2006 form in 2011.

Sec. 152: Dependent Defined

For tax years beginning after July 2, 2008, a custodial
parent’s release of a claim to exemption for a child must be
separate from a court decree or separation agreement. The IRS
provides guidance19 on the documentation that a
noncustodial parent must provide to the IRS to claim an
exemption for a child under Sec. 152(e). The chief counsel
advice clarifies an inconsistency between IRS publications and
Regs. Sec. 1.152-4(e)(l)(ii). It states that a divorce or
separation agreement that allows the noncustodial parent to
claim an exemption for the child only if a condition is met
may not be used as documentation, even if it is accompanied by
a statement intended to show that the condition was met.

A custodial parent’s release must be on Form 8332,
Release/Revocation of Release of Claim to Exemption for Child
by Custodial Parent, or in a document that conforms to the
substance of Form 8332 and has as its only purpose the release
of a claim to exemption. However, a divorce decree or
separation instrument executed before July 3, 2008, that
unconditionally releases the right to claim an exemption of a
child may still be used.

In a Tax Court case, a
divorced taxpayer was not entitled to a dependency exemption
for his son.20 The son lived with the taxpayer’s
ex-wife, who was also the custodial parent. The son did not
meet the definition of either a qualifying child or a
qualifying relative for the taxpayer because he was not able
to prove that the son lived in the taxpayer’s principal place
of abode more than one-half of the tax year. Nor was the
taxpayer able to prove that he provided more than one-half of
the son’s support. In another case, the Tax Court held that a
taxpayer, who lived apart from her husband, was not entitled
to a dependency exemption for her two minor children who lived
with the taxpayer’s husband.21 The children did not
meet the definition of either a qualifying child or a
qualifying relative for the taxpayer.

Sec. 162: Trade
or Business Expense

Mileage: In a Tax Court case, the
taxpayer worked as a courier for an auto parts delivery
business using his own vehicle during 1999 and
2000.22 He began his day by driving to the
company’s warehouse, then made up to 15 stops on a circular
route, and finally returned home from his last stop. He drove
past that last stop on his morning drive to the warehouse. The
IRS denied a deduction for the mileage between his home and
the warehouse (98 miles), as well as between his home and the
last stop (12 miles), as commuting miles. They further denied
the mileage of the circular route because no substantiation
was provided by the taxpayer.

On the commuting miles
issue, the Tax Court allowed a deduction for the 86 miles
between the last stop and the warehouse, only denying a
deduction for 24 miles total (12 miles to and from his last
stop). The taxpayer provided proof that his home and records
were destroyed by fire in 2004. He further testified that he
was required to keep a log of each stop to record parts picked
up or delivered and payments received. He stated that he
included the mileage driven for each stop in these logs. The
Tax Court found his testimony to be credible and accepted the
claimed mileage under Temp. Regs. Sec. 1.274-5T(c)(5).

Education: In another case, the taxpayer
was a teacher in California with an emergency
credential.23 He had continuing education
requirements to maintain that credential, which could also
qualify him for a preliminary credential (which was a more
permanent position). The IRS denied the education expenses on
the basis that the taxpayer incurred them to meet the minimum
educational requirements in his trade or business. Although
the court had previously ruled against the IRS in a similar
case,24 the IRS claimed that a change in California
law rendered that decision irrelevant. The Tax Court held that
the difference cited by the IRS (essentially the time period
to complete additional educational requirements) was without
distinction. It changed the form but not the substance or
effect of the California requirements. Therefore, it allowed
all the claimed educational expenses.

Sec. 163:
Interest

Mortgage deduction limit:The IRS, in
chief counsel advice,25 has ruled that indebtedness
that is incurred to acquire, construct, or substantially
improve a residence, thus satisfying Sec. 163(h)(3)(B)(i), but
that exceeds $1 million, so not satisfying Sec.
163(h)(3)(B)(ii), is not acquisition indebtedness. Therefore,
home equity indebtedness, as defined in Sec. 163(h)(3)(C),
includes indebtedness incurred to acquire, construct, or
substantially improve a qualified residence, to the extent
that the indebtedness exceeds the $1 million limit on
acquisition indebtedness and to the extent the other
requirements of Sec. 163(h)(3)(C) are satisfied.

A
taxpayer had posed a scenario in which he had borrowed $1.3
million to acquire his new residence and wanted to deduct the
interest on $1.1 million. In the ruling, the IRS stated, “We
recognize that the position taken in this memorandum is
inconsistent with Pau v. Commissioner, T.C. Memo.
1997-43 and Catalano v. Commissioner, T.C. Memo. 2000-82, regarding the
definition of acquisition indebtedness in §163(h)(3)(B).
However, we believe that the position in this memorandum is
the better interpretation of §163(h)(3)(B) and (C).”

Qualified mortgage insurance premiums: The IRS has published proposed
regulations explaining how individuals may allocate prepaid
qualified mortgage insurance premiums to determine the amount
of the prepaid premium that is treated as qualified residence
interest each tax year under Sec. 163(h)(4)(F).26
The text of simultaneously released temporary regulations also
serves as the text of the proposed regulations.27

Sec. 183: Activities Not Engaged in for Profit

The IRS issued a notice of deficiency after denying
taxpayers losses from their horse breeding and boarding
operation for tax years 1997–2002.28 The activity
had produced a Schedule F loss starting in 1993. Despite this
continual string of losses, the Tax Court ruled that the
taxpayers had engaged in an activity for profit and allowed
the losses. While several of the nine factors listed in Regs.
Sec. 1.183-2(b) favored the IRS, the Tax Court judged the
majority to be in the taxpayers’ favor. Among the key facts
favoring the taxpayers were:

They spent nine
years in court seeking clear title to an Arabian horse for
breeding. During those years they had possession of the
horse and were able to derive pleasure from its possession,
but the horse’s breeding value was nil due to the ownership
question.

The taxpayers’ other
income during this period never exceeded $65,000, indicating
that they were not looking to shelter income.

The court found that the taxpayers derived little personal
pleasure from the activity. They specifically noted that the
taxpayer’s daughter often refused to visit her father to avoid
working in the barns.

Sec. 213: Medical, Dental,
etc., Expenses

The taxpayer claimed medical
deductions in 2004 and 2005 for pornographic materials and
visits to prostitutes.29 The IRS denied the
deductions. The taxpayer claimed that there was extensive
evidence about the positive health effects of sex therapy. He
further argued that the IRS should allow the deductions
despite the fact that the activity (prostitution) was illegal
and no doctor had prescribed the treatment. The Tax Court
rejected his arguments. Because the taxpayer had been an
attorney specializing in tax law for 40 years, the court also
upheld the Sec. 6662 accuracy-related penalty.

Sec.
280A: Disallowance of Certain Expenses in Connection with
Business Use of Home, Rental of Vacation Home, Etc.

A
district court denied deductions for items purchased for the
taxpayer’s home office because the taxpayer failed to
substantiate that he used the home office exclusively for
business purposes.30 The Tax Court held similarly
in another case.31

In a third case, the Tax
Court denied the taxpayers’ claim of an additional business
expense for internet and satellite TV charges because they
were not able to show that these expenses were not already
included within “utilities” on Form 8829, Expenses for
Business Use of Your Home, as part of the home office
deduction.32

Sec. 1001: Determination of
Amount of Gain or Loss

In a Tax Court case, a
taxpayer attempted to change his transaction form after the
sale of his RV park.33 The sale occurred in an S
corporation in which the taxpayer was the sole stockholder.
The Tax Court held that the taxpayer’s claim that the RV park
had been transferred to an offshore insurance company before
the sale reflected an impermissible belated attempt to change
the transaction’s original form.

In another
case,34 the taxpayers argued that they were not
liable for an asserted deficiency for capital gains on the
liquidation of S corporation stock because the IRS had not
explained how it calculated the gain. The Tax Court held that
the taxpayer had the burden of proof on the issue and was thus
required to show that the IRS’s determination of the ownership
of the stock and the calculation was incorrect.

Sec.
1031: Exchange of Property Held for Productive Use or
Investment

The Ninth Circuit affirmed a Tax Court
decision denying nonrecognition of gain in a four-party
exchange.35 It determined that related parties’
primary purpose in the exchange swap was to cash out of a
low-basis property while avoiding recognition of gain.

The IRS ruled that application of Sec. 1031(a) to a
taxpayer is not affected by a trust’s sale of its interest in
farmland within two years of its acquisition, including
interest that the trust acquired from a taxpayer, where the
taxpayer and the trust are not related persons under Sec.
1031(f).36

Sec. 1033: Replacement of
Livestock with Other Farm Property in Certain Cases

In Notice 2009-81,37 the IRS listed the counties
that qualified for an extended replacement period for
taxpayers to replace livestock that they sold due to drought,
flood, or other weather-related conditions. The IRS may extend
the replacement period on a regional basis for such additional
time as it determines appropriate if the weather-related
conditions that resulted in the area being designated as
eligible for assistance by the federal government continue for
more than three years.

Sec. 1221: Capital Asset
Defined

The Tax Court held that married taxpayers who
were investment planners properly claimed capital gain
treatment from the sale of excess lots, which they purchased
as part of a single property on which to build their dream
home but subsequently decided to subdivide.38 The
court held that the overall facts and circumstances, including
the fact that the taxpayers had full-time jobs, engaged in
minimal solicitation and advertising, sold relatively few
lots, and had originally intended to keep the entire lot for
themselves, showed that the taxpayers held the property as a
capital asset and not as property held for sale to customers
in the ordinary course of business. But the taxpayers were not
entitled to recognize loss from a related-party sale where
they failed to address the issue on brief.

Sec. 6015:
Innocent Spouse Relief

According to the IRS Office of
Chief Counsel, the IRS plans to revise the regulations
governing innocent spouse relief provisions under Sec. 6015 in
response to a number of recent Tax Court decisions, including Lantz39 and Porter.40

In a
chief counsel notice, the IRS provided guidance on the scope
and standard of review in cases involving requests for relief
from joint and several liability under Sec.
6015(f).41 The notice supplements Chief Counsel
Notice CC-2004-26.42 In chief counsel advice, the
IRS clarified prior advice on whether to treat a liability as
an underpayment or an understatement in a situation in which
innocent spouse relief is claimed by one spouse and the other
spouse agrees to the liability.43

The Tax
Court held that the doctrine of res judicata barred an
individual from raising the issue of Sec. 6015 innocent spouse
relief in a case challenging his and his wife’s joint
liability for three tax years, finding that the taxpayer had
raised the issue in a previous Tax Court case for the same tax
years and meaningfully participated in that case.44

Sec. 7703: Determination of Marital Status

The IRS has advised that during incarceration, either pre-
or post-conviction, a taxpayer may be considered only
temporarily absent from his place of abode, depending on his
or her intention to return and other factors.45

EditorNotes

Ellen Cook is
assistant vice president for academic affairs and a professor
at the B.I. Moody III College of Business Administration at
the University of Louisiana in Lafayette, LA. Anna Fowler is
professor emeritus at the University of Texas at Austin.
Edward Gershman is a partner with Deloitte & Touche LLP in
Chicago, IL. Janet Hagy is a shareholder in Hagy &
Associates PC in Austin, TX. Jonathan Horn is a sole
practitioner specializing in taxation in New York, NY. Annette
Nellen is a professor at San Jose State University in San
Jose, CA. Darren Neuschwander is a shareholder in
Neuschwander, Faircloth & Hardy, P.C., in Robertsdale, AL.
Dennis Newman is a senior tax manager with Sharrard, McGee
& Co., P.A., in Greensboro, NC. Nora Stapleton is a
partner with Blackman Kallick LP in Chicago, IL. The authors
are all members of the AICPA’s Individual Income Tax Technical
Resource Panel. For more information about this article,
please contact Ms. Cook at edcook@louisiana.edu.

The winners of The Tax Adviser’s 2016 Best Article Award are Edward Schnee, CPA, Ph.D., and W. Eugene Seago, J.D., Ph.D., for their article, “Taxation of Worthless and Abandoned Partnership Interests.”

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